OPEC oil cut to draw inflation higher?

Hello everyone! This week I will be analysing the causes and impact of the OPEC oil cuts on the global oil market and economies around the world.

On 5th September, OPEC+ (Organisation of Petroleum Exporting Countries) announced its largest oil cuts since the start of the pandemic. It announced to slash oil production by 2 million barrels per day (bpd). The report put economists across the globe in a fix as this move could hit the global economy negatively which is already suffering from slow growth accompanied by high inflation rates. Western and Asian economies are still experiencing record-high inflation rates in recent months given the shock waves from the Ukraine war and are bracing for yet another impact from the oil cuts. The US has strongly condemned the damaging move by OPEC with President Biden calling it 'shortsighted'. The de facto leader of OPEC, Saudi Arabia has stated the key reason behind the cuts as a move to stabilise prices in the oil market however economists believe that the step comes as oil producers fear a sudden collapse of the global economy that is steadily going downhill due to spiralling inflation, thus making countries lose their purchasing power. However, the move by OPEC is expected to push price levels even higher in economies around the world especially South Asian economies which are highly dependent on oil imports. The decision also has the potential to mask the effect of western sanctions on Russian oil which has been shunned from European markets.

Key Reasons behind cuts:

At the start of the pandemic, the demand for crude oil took a hard hit and the prices went down significantly. This resulted in huge losses to big oil-exporting countries such as Saudi Arabia, other members of OPEC and Russia. Nations dependent on oil exports saw their revenues go down significantly. OPEC countries now fear a similar situation as the global economy heads into a recession. Russia's war in Ukraine has triggered high inflation rates across the globe and this has led to the declining demand for oil due to less purchasing power of consumers. Oil producers are worried about a sudden collapse in oil prices if economies go down faster than expected. This has made OPEC cut oil production and thus keep the prices in the market high to ensure high revenue and avoid a situation like the pandemic in 2020.

Will OPEC cuts make inflation worse?

Since OPEC announced the cuts on oil production, the prices in the oil market have been on the rise. This decision has made policymakers worried who fear that inflation is expected to become even worse. Brent crude is expected to touch $100 per barrel by December, which touched $92 per barrel a day after the cuts. South Asian economies are expected to feel the pinch as OPEC supplies two-thirds of oil to these countries which are highly dependent on oil imports. The move is also likely to make the situation worse for Europe which is already suffering from gas cuts by Russia. EU planned to shift to oil for its heating and electricity however, given the recent hikes in oil prices energy crisis is expected to worsen in Europe. The US had requested OPEC to increase production and decrease the oil prices further but it has done the 'exact opposite' which is expected to make inflation worse in the US, which is already dealing with 40-year high inflation. The pattern thus suggests that consumers around the world are expected to see their energy bills skyrocketing.

Impact on Russian Oil:

The Russian economy, which gets a third of its revenue from oil export is expected to gain a lot from higher oil prices. Since Russia's invasion of Ukraine, Russian oil has been shunned from Western and European markets leading to huge market losses for the nation. Russia has however found new buyers in Asia, India and China being the largest, which jointly have purchased more Russian oil than the 27 EU members in recent months. Squeezing supplies from the oil market, which has high demand, is expected to push up prices and will help Russia fill its coffers. This also suggests that the European plan of stopping Putin's war machine in Ukraine through oil embargos has dramatically failed.

Analysis:

The OPEC oil cuts will have a huge and far-ranging impact on economies around the world. Oil is the basic source of energy and thus a rise in oil prices will affect the price levels of all the goods in the economy. To reduce the impact of the oil cuts, the US has released some of its strategic oil reserves in the market to stabilise the prices, however, economists believe that these reserves are shrinking at a very fast rate and are having minimal impact on the global oil prices. The rising oil prices are expected to worsen the cost of living crisis in economies around the world, especially in the UK and European nations. People are already grappling with high inflation rates and these increased oil prices will further bring down economic growth thus increasing fears of the Global Economic Recession in 2023.

India and China, two of Asia's largest economies have been purchasing discounted Russian oil since February but now they could also see oil prices rise, however, the impact is expected to be limited due to the discounted price. The economies that are going to be the hardest hit by these oil cuts are the Western and European economies which have already banned Russian oil from their markets and now the further oil cuts will lead to even fewer supply options. The US which is the second largest importer of crude oil has sharply criticised OPEC and Saudi Arabia, particularly for the oil cuts.

To reduce the impact of oil cuts on their economies, nations can either release their own strategic oil reserves or look for new potential suppliers in the market like Azerbaijan, South Sudan and Oman which are not a part of OPEC, to fight the problem in the short term. However, to fight this problem in the long term, nations must choose alternative sources of energy like Solar and Wind energy thus reducing their dependency on oil. Nations should also try and break the dominance and market power of OPEC in the oil market and thus reduce their ability to control oil prices.

Conclusion:

The oil production cuts by OPEC have ringed alarm bells across economies that are already suffering from record inflation rates and stagnant economic growth. The nations that are highly dependent on oil imports such as India face a higher risk in case the prices reach $100 per barrel as predicted by economists. The rise in oil prices will thus slow down the recovery of economies. There are also growing concerns about the Saudi-led oil cartel swinging prices in their favour by supply cuts and exploiting their consumers, therefore can nations ensure breaking through the dominance of the 'largest oil cartel' in the World?

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References:

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